“The best time to plant a tree was twenty years ago…
The second best time is today.”
Chinese proverb
For nearly 35 years, I have represented commercial real estate investors, developers, and business owners. Most of that time has been spent helping them acquire, finance, expand, develop, manage and grow their assets and businesses. Over the past 5 to 6 years, as we struggle through the great recessiona great deal of my time has been spent helping clients maintain their assets.
Growing up, I was steeped in the practical insight that it’s not so much what you get, but what you keep that counts. My parents and grandparents were not in the real estate business to enrich others. They were playing real life Monopoly®. They played to win. It wasn’t so much money for money as a means of keeping score. Invest. Reinvest. Expand the bottom line. Control your losses. And keep what you buy.
A key concern has always been asset protection. Perhaps this was a byproduct of my grandfather’s experiences during the Great Depression. He did well, while others around him lost everything. One theme that underpinned virtually every investment strategy was structuring our business affairs in remote risk pools, so that if bad things happened to a project, or to a business, the damage could be contained. My father would compare it to the structure of his ship in the Navy during World War II. If the hull was damaged, watertight bulkheads could contain the damage to avoid endangering the entire ship.
This brings to light one of the big misconceptions about asset protection. A considerable number of people start out with the belief that the goal of asset protection is to prevent all creditors from ever getting any of your assets or income. Realistically, it doesn’t work that way. Not even if you use an offshore asset protection trust or other advanced asset protection devices. To even come close to making that happen, you would have to create such a tangled web of trusts and limited liability entities, and relinquish so much control, that you could never run your business or live your life as a functional human being. It would be immensely expensive, and even then it wouldn’t protect everything.
Asset protection doesn’t have to be particularly complicated or expensive. Basic asset protection strategies can be implemented that do not interfere with your business or your daily life. Although advanced asset protection planning can use trusts and offshore bank accounts, those tools and techniques are the exception rather than the rule. They are available if the situation warrants, but for most people there is rarely a legitimate reason to go to such lengths.
Unfortunately, a significant number of commercial real estate investors and business owners, and many of their attorneys and accountants, pay little attention to even basic asset protection strategies. This was never more obvious and unfortunate than during the Great Recession that we have been working through for the last five or six years. Otherwise, sophisticated and historically successful commercial real estate investors, developers, and business owners have lost virtually everything. What makes this even more tragic is that, with even modest asset protection planning, many of these catastrophic financial disasters could have been prevented.
Clients of mine who planned ahead when structuring their asset protection affairs have survived this recession and are generally well positioned to move forward and take advantage of emerging opportunities as the economy improves. Many of those who didn’t are faced with starting over.
Why not think ahead to protect your assets? You are under no legal obligation to structure your financial affairs in a way that makes it easier for banks and other creditors to seize virtually everything you own. Your obligation is to yourself and your family to ensure that your work and life savings are not lost in the event of a financial calamity.
A key point about asset protection is that, to be effective, it must be done well in advance. Once the proverbial fan has been hit, it’s probably too late. There may still be some moderately effective strategies that can be employed to minimize damage, but real asset protection with powerfully effective results begins when there are no (or at least very few) storm clouds on the horizon.
Once you’re in financial trouble, it’s often too late. Transfers of assets for less than fair value may be set aside as a preference in bankruptcy or as a fraudulent transfer. The “fraud” in “fraudulent transfer” is not traditional fraud. It is simply the transfer of an asset for less than fair value for the primary purpose of avoiding creditors.
In Illinois, the statute of limitations for fraudulent transfers is four years. This means that attempts to transfer assets for less than fair value can be attacked and voided for four years after the transfer takes place. For Medicaid, the look-back period is five years. Early adoption and implementation of even a simple asset protection plan can prevent these attacks.
One of the simplest examples of asset protection: If you are married and own a home with your spouse in Illinois or Indiana, and in most other states, there is virtually no excuse for not owning the home as tenants for the whole to protect your home from claims by single-spouse creditors. This is particularly true if one of the spouses is engaged in business or professional activities with a high risk of liability (entrepreneur, investor, promoter, doctor, entrepreneur, etc.), while the other is not. Shockingly, I discovered while defending real estate developers and investors in loan negotiation and settlement efforts over the past few years that even this modest asset protection tool is not always in place. It would have cost nothing. Instead, their absence costs some families their homes.
Beyond these fundamental considerations, there are many others. A common mistake business owners make is that they sometimes form a corporation or limited liability company with the intention of protecting themselves from personal liability, but then place virtually all of their business assets in one company or subsidiary. from a high risk operating company. If a judgment is entered against the business, all business assets may be lost.
Wherever practical, business operations that present a liability risk should be separated from ownership of the assets. Assets can and should be owned by a low-risk entity (preferably with tax advantages) and leased or licensed to the higher-risk operating company. The best and least expensive time to implement this structure is when you acquire the asset or business. Ownership of the low-risk business must also be held by a low-risk owner, perhaps a spouse, adult child, trust, or holding company. The asset protection plan can, and often should, be part of a more comprehensive estate plan.
Similarly, real estate investments and commercial ownership structures are often not adequately designed to combat liability risk arising from loan and lease guarantees or other sources of liability for individual sponsors or directors.
Much can be done to protect your assets. Many techniques also have tax advantages. Exactly what can be done depends on your particular circumstances and when you start. The best time to start would have been several years ago. The second best time to start is now. It is foolish to leave your hard-earned assets needlessly exposed to creditor claims when even basic asset protection planning can protect them.
War stories abound from commercial real estate investors and business owners who have lost fortunes, large and small, because they failed to plan ahead. Perhaps they thought they were smart enough to avoid financial catastrophes like the ones we have experienced in recent years. Or they thought they had a large enough income or net worth to withstand financial hardship or unexpected liability. Or they believed they had such excellent relationships with their banks or other lenders that getting loan extensions or new lines of credit for working capital would never be a problem. I’ve covered most of the “reasons,” but none of them matter when your assets are being repossessed by hungry creditors. When you go from being worth millions to having huge unsatisfied deficiency judgments against you, the reasons for not protecting your assets and your family’s future ring hollow.
The last five or six years, in particular, have been a laboratory for asset protection. The theory has been proven. We’ve seen many examples of even basic asset protection techniques that work, and sadly, we’ve seen what happens when little or no asset protection planning is done.
If your real estate investments and business activities are worth your time and energy, particularly if you spend most of your adult life away from your family working to make them successful, then they are worth protecting. It is much more cost-effective to develop and implement an asset protection plan “on the fly” rather than wait until you decide your estate is “big enough to protect.” At that point, it may be too late, it will certainly be more expensive, and it will most likely be less effective. Oftentimes, asset protection on the go will cost no more to get right than it will cost to get it wrong.
A great deal of reconstruction will take place in the coming years. Literally, in the form of new and redesigned commercial real estate projects and business ventures, and figuratively, as formerly successful real estate professionals and business owners rebuilding their financial lives. Don’t make the same mistakes this time that many have made in the past. Plan ahead. Incorporate basic asset protection strategies into every business structure you operate. Don’t wait another twenty years. You may not get a third chance.
Thank you for your time…
kymn
